M-102

Unit III
DEMAND FORECASTING
Demand Forecasting refers to the process of predicting the future demand for the firm’s
product. In other words, demand forecasting is comprised of a series of steps that involves the
anticipation of demand for a product in future under both controllable and non-controllable
factors. Demand Forecasting is the process in which historical sales data is used to develop an
estimate of an expected forecast of customer demand. To businesses, Demand Forecasting
provides an estimate of the amount of goods and services that its customers will purchase in the
foreseeable future. Critical business assumptions like turnover, profit margins, cash flow, capital
expenditure, risk assessment and mitigation plans, capacity planning, etc. are dependent on
Demand Forecasting.
In simple words — “Demand forecasting is an estimate of future sales”. From a Company’s
or Firm’s point of view — “Demand Forecasting means deciding in advance its share in the
Total Market Demand”.

Categories of Demand Forecasting:

Level of Nature of
Time Period
Forecasting goods
• Firm (Micro) • Short term • Consumer
Level • Long term goods (Direct
• Industry Level demand)
• Economy • Capital goods
(Macro) level (Derived
demand)

STEPS INVOLVED IN DEMAND FORECASTING

1. Identification of business objectives:

In the first stage we should know what is the aim of forecasting? What we get or know from the
forecasting? Estimation of factors like quantity and composition of demand for goods, price to be
quoted, sales planning and inventory control etc., are done in the first stage.

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2. Determining the nature of goods under consideration:
Different category of goods has their own distinctive demand. Example capital goods, consumer
durables and non-durables goods in which category our goods fall we should estimate.
3. Selecting a proper method of forecasting:
There are different methods for demand forecasting. Which is best suited method that we should
select for doing demand forecasting?
4. Interpretation of results:
The forecasting which is done by the managerial economist should be interpreted in detailed
manner. That means it should be easy to understand by the top management.

Techniques/Methods of Demand Forecasting:

The activity of estimating the quantity of a product or service that consumers will purchase is
demand forecasting. Demand forecasting involves techniques including both informal methods,
such as educated guesses, and quantitative methods, such as the use of historical sales data or
current data from test markets. Demand forecasting may be used in making pricing decisions, in
assessing future capacity requirements, or in making decisions on whether to enter a new market.
Choice of a forecasting technique depends on objectives, costs, time, nature of data, and
complexity of the technique. For the sake of convenience, the techniques may be categorized as:
a) Qualitative/Subjective
b) Quantitative

•Consumers’ opinion survey

•Sales force Composite method
•Experts Opinion
Qualitative/Subjective •Market Stimulation
methods •Test Marketing

•Trend Projection
•Smoothing Techniques
Quantitative methods •Barometric Techniques
•Econometric Methods

Qualitative Methods:

a) Consumers’ Opinion Survey:

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 Buyers are asked about their future buying intentions. Two ways to conduct survey

 Census method
 Sample method

b) Experts’ Opinion Method:

In Survey of Expert’s Opinions, the specialized group of people in the concerned fields, from
both inside and outside the organization, are approached and asked to give their opinions on sales
trend. The experts from both inside and outside the organization are approached to give their
estimates on sales. This is a comprehensive sale forecasting method that helps in developing
the overall industry sales forecast.

The expert’s opinions method is used when the organization wants the forecast to be more
accurate and which holds true for the entire industry. This is only possible through the group of
experts who have the complete information on the overall economic environment and the
conditions prevailing in the industry. Hence, people from outside the organization, who are very
close to the market are approached and are required to sit with the company’s executives and
reach to the final forecast.

The Survey of Expert’s Opinions gives due weights to the experience and expertise of people
who know the market and the firm. This method, when employed successfully can give accurate
forecasts. Important types of opinion methods are:

a) Group Discussion
b) Delphi Technique

The Delphi Technique: A panel of experts is appointed to produce a Demand Forecast. Each
expert is asked to generate a forecast of their assigned specific segment. After the initial
forecasting round, each expert reads out their forecast and in the process, each expert is
influenced by other experts. A consequent forecast is again made by all experts and the process
is repeated until all experts reach a near consensus scenario.

The method is used for long term forecasting to estimate potential sales for new products. This
method presumes two conditions: Firstly, the panelists must be rich in their expertise, possess
wide range of knowledge and experience. Secondly, its conductors are objective in their job. This
method has some exclusive advantages of saving time and other resources

c) Sales Force Composite Method :

The Sale Force Composite Method is a sale forecasting method wherein the sales agents
forecast the sales in their respective territories, which is then consolidated at branch/region/area
level, after which the aggregate of all these factors is consolidated to develop an overall company
sales forecast.

The sales force composite method is the bottom-up approach where the sales force gives their
opinion on sales trend to the top management. Since, the salesmen are the people, who are very

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close to the market, can give a more accurate sales prediction on the basis of their experience
with the direct customers.

d) Market Stimulation:

It is like laboratory testing of consumer behavior. The Grabor-Granger test is popular technique
of market stimulation. In this method, half of the members of a group of consumers are shown
the new product for purchasing and then existing product is shown. The other half is shown the
existing product first and then the new product.

e) Test Marketing:

The product is actually sold in certain segments of the market, regarded as the ‘test market.’
Demand is forecasted on the basis of actual sales of the product in the test markets

Quantitative methods:

f) Trend projection method:

Trend projection method can be effectively deployed for businesses with a large sales data
history of typically more than 18 to 24 months. This historical data generates a “time series”
which represents the past sales and projected demand for a specific product category under
normal conditions by a graphical plotting method or the least square method.

Time series data are composed of:

a) Secular trend
b) Seasonal trend
c) Cyclical trend
d) Random trends

The trend projection method is based on the assumption that the factors liable for the past trends
in the variables to be projected shall continue to play their role in the future in the same manner
and to the same extent as they did in the past while determining the variable’s magnitude and
direction.

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1. Graphical Method: It is the simplest statistical method in which the annual sales data are
plotted on a graph, and a line is drawn through these plotted points. A free hand line is
drawn in such a way that the distance between points and the line is the minimum. Under this
method, it is assumed that future sales will assume the same trend as followed by the past sales
records. Although the graphical method is simple and inexpensive, it is not considered to be
reliable. This is because the extension of the trend line may involve subjectivity and personal
bias of the researcher.
2. Fitting Trend Equation or Least Square Method: The least square method is a formal
technique in which the trend-line is fitted in the time-series using the statistical data to
determine the trend of demand. The form of trend equation that can be fitted to the time-series
data can be determined either by plotting the sales data or trying different forms of the equation
that best fits the data. Once the data is plotted, it shows several trends. The most common types
of trend equations are:

 Linear Trend: when the time-series data reveals a rising or a linear trend in sales, the following
straight line equation is fitted:
S = a + bT
Where S = annual sales; T = time (years); a and b are constants.
 Exponential Trend: The exponential trend is used when the data reveal that the total sales have
increased over the past years either at an increasing rate or at a constant rate per unit time.

3. Box-Jenkins Method: Box-Jenkins method is yet another forecasting method used for
short-term predictions and projections. This method is often used with stationary time-
series sales data. A stationary time-series data is the one which does not reveal a long
term trend. In other words, Box-Jenkins method is used when the time-series data reveal
monthly or seasonal variations that reappear with some degree of regularity.

g) Smoothing Techniques:

These are used when the time series data exhibit little trend or seasonal variations, but a great
deal of irregular or random variations. Important methods are:

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  Moving average
 Weighted moving average
 Exponential smoothing

h) Barometric technique: Barometric technique of Demand Forecasting is based on the

principle of recording events in the present to predict the future. In the Demand
Forecasting process, this is accomplished by analyzing the statistical and economic
indicators. Generally, forecasters deploy statistical analysis like Leading series,
Concurrent series or Lagging series to generate the Demand Forecast.

The barometric method is based on the approach of developing an index of relevant economic
indicators and forecasting the future trends by analyzing the movements in these indicators. A
time-series of several indicators is developed to study the future trend. These can be classified as:

1. Leading Series: The leading series is comprised of indicators which move up or down ahead of
some other series The most common examples of leading indicators are- net business investment
index, a new order for durable goods, change in the value of inventories, corporate profits after
tax, etc.
2. Coincidental Series: The coincidental series include indicators which move up and down
simultaneously with the general level of economic activities. The examples of coincidental series
– the rate of unemployment, the number of employees in the non-agricultural sector, sales
recorded by manufacturing, retail, and trading sectors, gross national product at constant prices.
3. Lagging Series: A series consisting of those indicators, which after some time-lag follows the
change. Some of the lagging series are- outstanding loan, labor cost per unit production, lending
rate for short-term loans, etc.

The only advantage of the barometric method of forecasting is that is helps to overcome the
problem of finding the value of an independent variable under regression analysis. The major
limitations of this method are; First, Often the leading indicator of the variable to be forecasted
is difficult to find out or is not easily available. Secondly, the barometric technique can be used
only for a short-term forecasting.

i) Econometric forecasting technique:

Econometric forecasting utilizes autoregressive integrated moving-average and complex

mathematical equations, to establish relationships between demand and factors that influence the
demand. An equation is derived and fine-tuned to ensure a reliable historical representation.
Finally, the projected values of the influencing variables are inserted into the equation to
generate a forecast.

The econometric methods are comprised of two basic methods, these are:

1. Regression Method: The regression analysis is the most common method used to forecast the
demand for a product. This method combines the economic theory with statistical tools of
estimation. The economic theory is applied to specify the demand determinants and the nature of

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the relationship between product’s demand and its determinants. Thus, through an economic
theory, a general form of a demand function is determined. While the statistical techniques are
applied to estimate the values of parameters in the projected equation.

For a single variable demand function, the simple regression equation is used while for
multiple variable functions, a multi-variable equation is used for estimating the demand for a
product.

2.Simultaneous Equations Model: Under simultaneous equation model, demand forecasting

involves the estimation of several simultaneous equations. These equations are often the
behavioral equations, market-clearing equations, and mathematical identities.

(Note: Read the advantages and disadvantages of all techniques of Demand Forecasting on your
own.)

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